Nothing has changed on those counts, but Suncor (ticker: SU) and Canadian Natural Resources (CNQ) have fallen out of favor over the last few years as strong growth in U.S. oil and gas production reduced the need for Canadian energy exports, hurting prices for Canadian crude.

The depressed shares of both companies look appealing trading for a fraction of their 2008 peaks. Suncor, at $31, trades for 9.5 times projected 2013 profits of C$3.27 a share, while Canadian Natural Resources, at $29, fetches 13 times estimated '13 earnings of C$2.22 a share. These per-share figures are presented in Canadian dollars, which trade close to parity with the U.S. currency. Shares of both companies trade actively in the U.S.

The two companies are valued on par with U.S. exploration and production companies at about five times estimated 2013 pre-tax cash flow, yet have more attractive assets than their U.S. peers. Both stocks could trade into the $40s during the next year, based on price targets from Macquarie energy analyst Chris Feltin.

Both companies could become targets for activist investors given their valuable asset bases and low share prices. While big Canadian investors tend to be docile, American investors are less restrained. Bill Ackman of Pershing Square Management took a big stake in Canadian Pacific, the railroad company, in late 2011 and pushed for board and management changes. He succeeded, and CP shares have nearly doubled since then.

A takeover of either Suncor or Canadian Natural Resources by a larger international energy company is a long shot, however, because the Canadian government probably wouldn't permit it. Suncor now limits any holder to a 20% stake.

There's a different investment case for each company. Suncor, an integrated energy company with a big presence in the Alberta oil sands and lucrative refining operations, is the safer of the two because it's producing significant free cash flow. It has the ability to sharply boost its dividend, now 1.6%, and faces investor pressure to do so.

Canadian Natural Resources generates little free cash flow because of weak prices for heavy oil and natural gas, which account for 70% of its output. Canadian Natural Resources amounts to a bet on the company's well-regarded management team, led by veteran oilman Murray Edwards, and a rebound in Canadian oil prices.

The company will benefit if President Obama approves the controversial Keystone XL pipeline, a 1,179-mile link from Alberta to Nebraska would offer an outlet for land-locked Canadian crude. That could narrow the big discount of Canadian heavy crude, which now trades at $25, or 27%, below the U.S. benchmark, West Texas Intermediate, which fetches $93 per barrel. Historically the discount has been closer to $15 a barrel. There's a double discount on Canadian heavy crude since WTI trades at a wide $20 discount to Brent, an international benchmark.

The bear case on the stocks is that a boom in U.S. crude production will depress Canadian crude prices for an indefinite period and that Suncor and Canadian Natural Resources rely on a high-cost and polluting source of crude. Any future carbon-emissions rules or other environmental restrictions would hurt them. The risk of tough environmental legislation doesn't appear to be high thanks in part to Alberta's reliance on oil-sands tax revenues.

SUNCOR IS CANADA'S largest energy company by market value at $47 billion. It's also a rarity among global integrated companies because it generates ample free cash flow and probably is capable of mid-single-digit annual production growth. It's tough for majors to do both because of high exploration costs.

Suncor's main advantage is that it gets more than 350,000 barrels a day of oil production—60% of its energy output—from the Alberta oil sands, where it has a conservative reserve life of 34 years and potential reserves to last a century. About 90% of its production is oil, so it is little- exposed to the weak North American natural-gas market.

Activist Targets?

Both companies could attract activist investors thanks to depressed stock prices and valuable assets. Larger dividends or buybacks could help.

Canadian Natural Resources

Suncor

Ticker

CNQ

SU

Recent Price

$29.42

30.92

12-Month Change

-23%

-13

2013E EPS

$2.22

3.27

2013E P/E

13.3

9.5

Dividend Yield

1.4%

1.6

Market Value (bil)

$32.1

47.1

E=Estimate. Source: Thomson Reuters

In a client note earlier this month, Macquarie analyst Chris Feltin wrote that Suncor is "inexpensive relative to peers" while "delivering solid production growth and peer-leading free cash growth … Suncor remains in the advantaged position to drive a (P/E) multiple re-rate by aggressively increasing dividends versus investing in low-return growth projects."

On its fourth-quarter earnings conference call earlier this month, Suncor CFO Bart Demosky pointed to 20% annualized dividend growth in the past five years. The problem is that the starting dividend was so low that the payout is still meager compared with that of its peers. He said Suncor's board would be conducting its annual dividend review shortly while noting that the company "is looking to put excess funds to work."

CANADIAN NATURAL RESOURCES is a pure energy producer and therefore hasn't benefited like Suncor from outsize refining margins. It has less exposure to the oil sands than Suncor, at just 15% of daily output of about 660,000 barrels. About 45% of its production is heavy oil, which is dirtier and more costly to refine than West Texas Intermediate; 25% of its output is natural gas. Analysts see the company as a play on higher prices for Canadian heavy oil, which is among the lowest-priced crude grades in the world.

Several pipelines under consideration to bring crude out of Alberta, including the Keystone XL, a pipeline to Canada's East Coast, and another one to the Pacific all could benefit Canadian Natural Resources in the coming years. Even with weak pricing for most of its output, the company still expects to generate about $500 million of free cash flow this year. It's spending about $2 billion annually to expand production at its Horizon oil-sands facility, now producing about 100,000 barrels a day, to 250,000 barrels a day, by 2017 or '18.

The Bottom Line

Energy investors dumped stock of Suncor and Canadian Natural Resources as U.S. oil production rose. Their depressed shares could rise 30% or more.

Canadian Natural Resources has a restive investor base. On its third-quarter conference call in November, the company was pressed several times on why it wasn't more aggressive in buying back shares—its repurchases do little more than offset employee stock grants. Management responded that it favors a dividend and that as cash flow grows, more will be returned to holders.

Formerly must-own stocks for oil bulls, Suncor and Canadian Natural Resources still offer an excellent play on crude. Investors can now buy their shares at a discounted price and get access to reserves that should be around for decades to come.